Fed. Sec. L. Rep. P 97,588 Securities and Exchange Commission v. Stephen Murphy

Stephen Murphy appeals from a district court decision permanently enjoining him from violating the registration and anti-fraud provisions of the securities laws and requiring him to mail copies of the court’s order to present and future business associates and investors. 1 The court first granted summary judgment for the SEC on the registration violations; 2 then, after a trial on the fraud counts in which defendant put on no evidence, the court entered judgment for the SEC on those counts. Murphy contends that there were disputed material facts which made the grant of summary judgment improper and that the entry of that judgment invalidated the fraud judgment as well. He also argues that the court erred in granting an injunction against registration violations without hearing testimonial evidence and that the court deprived him of due process when it denied his Fed.R.Civ.P. 41(b) motion for dismissal. We affirm.

I. FACTS AND PROCEEDINGS BELOW

Stephen Murphy formed Intertie, a California company that provided financing, construction, and management of cable television systems, in December, 1971, and he was its president and director until February, 1974, when he became vice-president, treasurer and director. In May, 1975, he resigned from these positions after an unsuccessful proxy fight, but he regained control of the company in August, 1975, and became chairman of the board.

Intertie’s business involved the promotion of approximately 30 limited partnerships to which it sold cable television systems. Most commonly, Intertie would buy a cable television system, making a cash down payment and financing the remainder, and then sell it to a partnership for a cash down payment and non-recourse promissory notes in favor of Intertie and lease it back from the partnership. Murphy was the architect of this financing scheme, by which Intertie took in approximately $7.5 million from 400 investors. Intertie engaged International Securities Corporation (ISC), a securities brokerage firm, to sell most of these partnership interests, and it agreed that ISC would receive a 10 percent sales commission. ISC’s president, Jack Glassford, and ISC shared a three percent commission override. From this three percent, starting in the summer of 1974, Murphy received a one-half percent commission on the sales of partnership interests.

Under ISC’s sales program, representatives contacted potential investors to interest them in purchasing limited partnership shares in cable television systems. An ISC sales representative was usually the general partner in the venture. Intertie and ISC did not register the limited partnership interests as securities but relied on the private offering exemption of § 4(2) of the Securities Act, 15 U.S.C. § 77d(2) (1971), and on Rule 146,17 C.F.R. § 230.146 (1979), which provides a “safe harbor” for private placements that meet certain specified conditions.

Intertie took no steps to assure that the offering and sale were directed only to a small number of sophisticated, informed investors; in fact, it did not even number its memoranda so that it could monitor the *638 volume of offers made. Moreover, Murphy in his deposition stated that he felt that information, on qualifications of investors was often inadequate. Intertie relied on ISC to comply with the securities laws and agreed by letter to take whatever steps ISC requested for compliance. There was no written contract allocating this responsibility to ISC, however. Neither Intertie nor ISC assured that offeree representatives that the investors used were capable of providing informed advice, even though Murphy doubted the competence of many of the offeree representatives he met. 3 Some of the representatives were salesmen for ISC and a few acted as both salesman and general partner for a partnership.

ISC’s salesmen promoted sales of the partnership interests with offering memoranda describing Intertie as “the undisputed industry leader” and a company which could purchase, construct and operate cable television systems “better, faster, more profitably] and with less invested capital than ever before.” The memoranda, the salesmen, and Intertie did not disclose that Intertie was losing money, had large short-term debt obligations in connection with the acquisition of the cable television facilities which it resold to the limited partnerships, and could not continue to meet obligations of existing partnerships without refinancing debts or obtaining capital from new partnerships. Nor did they disclose that Intertie was commingling the funds from the various partnerships.

Offering memoranda represented that Intertie had “only a limited history of operations” and did not reveal that Intertie had sold cable systems to at least eight or nine partnerships by January, 1974, and at least twenty by August, 1974. The memoranda also projected that sale and lease-back arrangements would generate from six to ten percent cash flow, but they did not reveal that this flow depended upon Intertie’s ability to generate new funds through marketing additional systems, since the early revenues were sometimes inadequate to meet costs. 4 Often, projections for subscriber revenue significantly exceeded the amounts that Intertie later took in from a system.

The memoranda also stated that brokerage commissions would not exceed 10 percent and that tax benefits would arise from the partnership. Intertie continued to make the latter representations even after the Internal Revenue Service in 1974 questioned certain deductions taken in connection with a 1972 partnership. In addition, the memoranda described a negotiation and management role for the general partners that many of them did not assume, since most were ISC employees with little or no knowledge of the operation of cable systems.

Murphy participated heavily in the offerings. He prepared or reviewed Intertie’s offering memoranda and sales brochures and sometimes revised language written by Intertie’s lawyers; he drafted other materials for distribution to offerees of limited partnership interests; he met with ISC salesmen and with potential investors and their representatives, if any, to give them information about Intertie; and he presented the Intertie investment plan at sales seminars with broker-dealers.

Murphy did not make Intertie’s financial statements available to the investors. In his deposition, he described Intertie’s response to requests for financial information:

[S]ome guys called up particularly early in ’74 and said, “I have a potential investor and want to see Intertie’s financial statement,” and they were told, “if that is a condition, we are not going to furnish it.”

*639 [After June, 1974] [w]e generally answered their request by indicating that we did not feel . . . the Intertie statement was . . . required under Rule 146 and that we did not have the financial strength to be the guarantor of the lease or give the investor any place . . . where they would be able to look for some degree of security and if that did not solve the problem and they pushed for it, generally we would comply with it. But only after that process. Frankly, we didn't want to give the thing out.

By September, 1974, the company had a serious working capital deficiency and a negative net worth of over $600,000; its current assets were $2.3 million; its current liabilities were $6.4 million. Throughout 1974, Intertie used funds generated from new partnership offerings to meet Intertie’s debt service obligations on prior systems. Included in those funds were investments from two limited partnerships for systems in New Mexico, which Intertie never built, although it prepared tax returns on behalf of the partnerships and took an investment tax credit and accelerated depreciation on the non-existent facilities. In December, 1975, Murphy filed a petition for Chapter XI bankruptcy for Intertie, and Intertie is now a debtor in possession with Murphy as president.

In 1975, the SEC brought suit against Murphy and other defendants, charging violations of the registration and fraud provisions of the securities laws, and seeking injunctive relief. On March 6, 1978, the district court granted summary judgment for the SEC on the registration count, § 5(a) and (c) of the Securities Act of 1933, 15 U.S.C. § 77e(a), (c) (1971). The court issued a permanent injunction against acts in violation of the registration provisions of the 1933 Act. The SEC then proceeded to trial on the fraud counts, § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1970); § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970) and Rule 10b-5,17 C.F.R. 240.10b-5 (1979), promulgated thereunder. Murphy moved for dismissal of the action under Fed.R.Civ.P. 41(b), arguing that the Commission had not shown a reasonable likelihood of future violations, a prerequisite to entry of an injunction against him. The court denied the motion, stating that plaintiff had made out a prima facie case, and defendant rested without introducing any evidence.

The court entered judgment for the SEC on September 19, 1978, enjoined Murphy from future violations, and directed that he send copies of the court’s order to (1) each investor in each limited partnership that had a relationship with Intertie; (2) all present and future officers and directors of Intertie and Xanadex (another of Murphy’s cable television companies); (3) the general partner of any limited partnership which leases equipment or assets to Intertie' or Xanadex; and (4) any securities brokerage firm engaged by Murphy, Intertie or Xanadex to sell interests in limited partnerships with relationships with Intertie or Xanadex.

Murphy alleges error in all of the above-listed decisions.

II. SUMMARY JUDGMENT ON THE REGISTRATION COUNT

The district court granted summary judgment for the SEC on the registration count, finding a violation of § 5(a) and (c) of the 1933 Act, 15 U.S.C. § 77e(a) and (c) (1970), which forbid offers and sales of securities in interstate commerce unless a registration statement is in effect for the security.

The defendant argues that the court’s grant of summary judgment on the registration count was inappropriate because there were disputed facts material to the following issues: whether the limited partnership interests were securities, whether the securities were exempt from registration, whether the transactions were covered by the securities laws, and whether his activities were sufficient to subject him to liability. 5

*640 The standard for granting summary judgment is well known:

“Summary judgment is ‘proper only where there is no genuine issue of any material fact or where viewing the evidence and the inferences which may be drawn therefrom in the light most favorable to the adverse party, the movant is clearly entitled to prevail as a matter of law.’ ” Great Western Bank & Trust [v. Kotz], 532 F.2d [1252,] 1254 [(9th Cir. 1976)], (quoting Caplan v. Roberts, 506 F.2d 1039, 1042 (9th Cir. 1974)). Our standard of review is the same in securities litigation. Id.

Smith v. Gross, 604 F.2d 639, 641 (9th Cir. 1979).

Initially, the moving party has the burden under Fed.R.Civ.P. 56(c) of showing absence of a genuine issue of material fact, Adickes v. S. H. Kress & Co., 398 U.S. 144, 159, 90 S.Ct. 1598, 1609, 26 L.Ed.2d 142 (1970); Neely v. St. Paul Fire & Marine Ins. Co., 584 F.2d 341, 343-44 (9th Cir. 1978); but if the movant satisfies the initial burden, then the burden shifts to the opponent to come forward with specific facts showing that there remains a genuine factual issue for trial. Fed.R.Civ.P. 56(e); id. at 344. The opponent must present these facts in evidentiary form; he cannot rest on his pleadings. United States v. Allen, 578 F.2d 236, 237 (9th Cir. 1978); Smith v. Saxbe, 562 F.2d 729, 733 (D.C. Cir. 1977). Moreover, the evidence he offers in opposition to the motion for summary judgment must be “significantly probative” as to any fact claimed to be disputed. First National Bank of Arizona v. Cities Service Co., 391 U.S. 253, 288-90, 88 S.Ct. 1575, 1592-93, 20 L.Ed.2d 569 (1968); Ruffin v. Los Angeles County, 607 F.2d 1276, 1280 (9th Cir. 1979), cert. denied, 445 U.S. 951, 100 S.Ct. 1600, 63 L.Ed.2d 786 (1980).

Applying these standards, a reviewing court must examine the record to determine whether there was an absence of dispute as to the facts material to a registration violation. We have examined the pleadings, pretrial order, affidavits, and depositions, including Murphy’s testimony before the SEC, and the conclusions that follow reflect all inferences that can be drawn from those facts in the light most favorable to Murphy. See Spectrum Financial Cos. v. Marconsult, Inc., 608 F.2d 377, 380 (9th Cir. 1979).

A. Elements of a Section 5 Violation

Section 5 of the 1933 Act forbids the offer or sale of unregistered securities in interstate commerce, 3 L. Loss, Securities Regulation 1693 (2d ed. 1961), but § 5 does not apply if the securities are exempt from registration as a private offering, § 4(2), 15 U.S.C. § 77d(2) (1970), or are not offered or sold in a transaction by an issuer, underwriter or dealer, § 4(1), 15 U.S.C. § 77d(l) (1970).

1. Security

Murphy argues on appeal that the shares in limited partnerships in the cable television systems were not securities. That argument is disingenuous. An investment contract is a security. § 2(1), Securities Act of 1933, 15 U.S.C. § 77b(l) (1971); § 3(aX10), 15 U.S.C. § 78c(a)(10) (1971). Under the test for an investment contract established in SEC v. W. J. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244 (1946), a limited partnership generally is a security, Goodman v. Epstein, 582 F.2d 388, 408-09 (7th Cir. 1978), cert. denied, 440 U.S. 939, 99 S.Ct. 1289, 59 L.Ed.2d 499 (1979); McGreghar Land Co. v. Meguiar, 521 F.2d 822, 824 (9th Cir. 1975); 1 A. Bromberg, Securities Law: Fraud § 4.6 (332) (1969), because, by definition, it in *641 volves investment in a common enterprise with profits to come solely from the efforts of others. See SEC v. W. J. Howey Co., supra, 328 U.S. at 301, 66 S.Ct. at 1104; Black v. Payne, 591 F.2d 83, 87 (9th Cir.), cert. denied, 444 U.S. 867, 100 S.Ct. 139, 62 L.Ed.2d 90 (1979); SEC Release No. 33-3877, 32 Fed.Reg. 11705 (1967). In SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476 (9th Cir.), cert. denied, 414 U.S. 821, 94 S.Ct. 117, 38 L.Ed.2d 53 (1973), this court held that it would not confine the Howey test to situations where the term “solely from the efforts of others” applied literally, but would find that element satisfied when “the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.” Id. at 482. Here the investors had no managerial role whatsoever: the limited partnership interests clearly are securities.

2. Unregistered and Sold in Interstate Commerce

Murphy admitted in the pretrial order that the limited partnership interests were not registered, and he offered nothing to rebut the SEC’s evidence that the securities were offered and sold in interstate commerce.

3. Not Exempt from Registration

Murphy contends, however, that the limited partnership interests were exempt from registration under the private offering exemption in § 4(2) of the 1933 Act, 15 U.S.C. § 77(d)(2) (1970), or under Rule 146, 17 C.F.R. § 230.146 (1979), which each exempt certain private placements. These exemptions from registration provisions are construed narrowly, SEC v. Blazon Corp., 609 F.2d 960, 968 (9th Cir. 1979), in order to further the purpose of the Act: “To provide full and fair disclosure of the character of the securities, . . . and to prevent frauds in the sale thereof . . .” Securities Act of 1933, Ch. 38, Tit. 1, 48 Stat. 74 (1933). Once the SEC introduces evidence that a defendant has violated the registration provisions, the defendant then has the burden of proof in showing entitlement to an exemption. SEC v. Ralston Purina Co., 346 U.S. 119, 126, 73 S.Ct. 981, 985, 97 L.Ed. 1494 (1953); Doran v. Petroleum Management Corp., 545 F.2d 893, 899 (5th Cir. 1977); Pennaluna & Co v. SEC, 410 F.2d 861, 865 (9th Cir. 1969), cert. denied, 396 U.S. 1007, 90 S.Ct. 562, 24 L.Ed.2d 499 (1970).

On a motion for summary judgment, however, “it is the moving party who carries the burden of proof; he must show that no genuine issue of material fact exists . even though at trial his opponent would have the burden of proving the facts alleged.” Doff v. Brunswick Corp., 372 F.2d 801, 805 (9th Cir. 1966), cert. denied, 389 U.S. 820, 88 S.Ct. 39, 19 L.Ed.2d 71 (1967). See also BAW Mfg. Co. v. Slaks Fifth Avenue, Ltd., 547 F.2d 928, 930-31 (5th Cir. 1977). Thus, the SEC was entitled to summary judgment only if it demonstrated that there was no genuine issue of material fact as to Murphy’s affirmative defense or that, viewing the evidence and the inferences which could be drawn therefrom in the light most favorable to Murphy, the SEC was clearly entitled to prevail as a matter of law. See Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1254 (9th Cir. 1976); 6 Moore’s Federal Practice Part 2 ¶ 56.17[4] (1979). After reviewing the pleadings and the affidavits that were before the district court on the summary judgment motion, we have concluded that there was no genuine issue of material fact and that, therefore, the court’s grant of summary judgment was proper.

The question whether the sales of limited partnership interests in Intertie’s cable systems were entitled to exemption from registration requirements as private offerings is a very difficult one. The difficulty does not preclude summary judgment, however, because it arises not from complex or disputed facts but, instead, from the application of well-settled law to undisputed, albeit unusual, factual circumstances.

A court assessing the availability of a private offering exemption focuses upon *642 the issuer and the offerees, paying particular attention to the relationship between the two. See, e. g., Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir. 1978); Doran v. Petroleum Management Corp., Inc., supra, 545 F.2d at 900-02; Hill York Corp. v. American International Franchises, Inc., 448 F.2d 680, 690 (5th Cir. 1971). This assessment often requires a careful inquiry into the facts surrounding the offering, see, e. g., Doran v. Petroleum Management Corp., Inc., supra, 545 F.2d at 900-04; Parvin v. Davis Oil Co., 524 F.2d 112, 118 (9th Cir. 1975); SEC v. Asset Management Corp., [1979] Fed.Sec.L.Rep. (CCH) 197,278 at 96,970 (S.D.Ind.1979), and, of course, it requires knowledge of who was the issuer of the securities. The problem in this case, as the SEC conceded at oral argument, is that it is not clear who was the issuer of the securities at suit.

As defined in the 1933 Act, “ ‘issuer’ means every person who issues or proposes to issue any security.” § 2(4), 15 U.S.C. § 77b(4) (1970). In a corporate offering, the issuer generally is the company whose stock is sold. SEC v. Ralston Purina Co., 346 U.S. 119, 120, 73 S.Ct. 981, 982, 97 L.Ed. 1494 (1953); SEC v. Koracorp Industries, 575 F.2d 692, 695 (9th Cir.), cert. denied sub nom. Helfat v. SEC, 439 U.S. 953, 99 S.Ct. 348, 58 L.Ed.2d 343 (1978); SEC v. Universal Major Industries Corp., 546 F.2d 1044, 1045 (2d Cir. 1976), cert. denied sub nom. Homans v. SEC, 434 U.S. 834, 98 S.Ct. 120, 54 L.Ed.2d 95 (1977); SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1089 (2d Cir. 1972); Quinn & Co. v. SEC, 452 F.2d 943, 945 (10th Cir. 1971), cert. denied, 406 U.S. 957, 92 S.Ct. 2059, 32 L.Ed.2d 344 (1972); Pennaluna & Co. v. SEC, 410 F.2d 861, 864, (9th Cir. 1969), cert. denied, 396 U.S. 1007, 90 S.Ct. 562, 24 L.Ed.2d 499 (1970). Here there is no company issuing stock, but instead, a group of individuals investing funds in an enterprise for profit, Cal.Corp. Code § 15006(1), and receiving in return an entitlement to a percentage of the proceeds of the enterprise. That entitlement, a partnership share, is similar to a share of stock, however; and, just as a share of stock is considered issued by the corporation, so should a partnership share be considered issued by the partnership. 6

New courts have confronted this question, because the bulk of securities litigation involving partnerships has concerned allegations of fraud, where it was unnecessary to determine who was the issuer. 7 Moreover, even those courts assessing registration violations involving limited partnerships have given little or no discussion to the issuer question but have simply treated as the issuer the entities that organized the partnerships and determined the success or failure of their enterprises. See Doran v. Petroleum Management Corp., supra, 545 F.2d at 897-99, 901-04; SEC v. Asset Management Corp., supra, [1979] Fed.Sec.L.Rep. at 96,969; Bayoud v. Ballard, 404 F.Supp. 417, 420-23 (N.D.Tex.1975).

As has been emphasized repeatedly, the purpose of the Securities Acts is to “protect investors by promoting full disclosure of information thought necessary to informed investment decisions.” SEC v. Ralston Purina Co., 346 U.S. 119, 124, 73 S.Ct. 981, 984, 97 L.Ed. 1494 (1953); see Tcherepnin v. *643 Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967). The Acts constitute a comprehensive plan to insure this protection by requiring the filing of a registration statement containing material facts bearing upon the investment merit of securities which are publicly offered. SEC v. Continental Tobacco Co. of South Carolina, 463 F.2d 137, 154 (5th Cir. 1972).

In determining that a security qualifies as a private offering, then, we must make sure that the offerees are provided with or given access to the information that is material to their investment decision. See Doran v. Petroleum Management Corp., supra, 545 F.2d at 903. Information is material if there is substantial likelihood that a reasonable person would consider it important in deciding whether to invest. TSC Industries v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976); Kidwell ex rel. Penfold v. Meikle, 597 F.2d 1273, 1293 (9th Cir. 1979). In a corporate setting, the most obviously material information would be facts concerning the issuer, the corporation. In a limited partnership setting, information about the issuer— the partnership — would be of no value if the partnership did not predate the investor’s entry into the venture, and it might be of little value even if the partnership did have a history of operation. In the latter case, information about the partnership’s previous record would be material, but it would not, alone, be sufficient. The information crucial to the investment decision would be that concerning the entity which was responsible for the success or failure of the enterprise. Cf. Schedule A of the Securities Act ¶ 27, 15 U.S.C. § 77aa (1971) (requiring that the issuer furnish profit and loss statements of any business to be purchased with the proceeds of the offering).

Considered from this perspective, the treatment of defendants as issuers in the three cases cited above is clearly appropriate because in each case the defendants whom the court considered issuers would determine the value of plaintiff’s investment. 8

Here, Murphy himself conceded that information about Intertie’s finances was material to the decision whether to invest in a limited partnership that Intertie promoted. Given the realities of Intertie’s financing scheme, that concession was unavoidable. Intertie developed the partnership offering plan and assumed a major role in engaging investors. It engineered and operated the systems from which the investors would receive their returns. It managed many of the partnerships and it prepared tax forms for most of them. Without generating new capital through continued partnership offerings, Intertie could not meet its obligations on the systems sold to previous investors.

For all these reasons, Intertie clearly held the key to success or failure of the partnerships. Accordingly, Intertie was the entity *644 about which the investors needed information, and, therefore, it is properly considered the issuer of the securities for purposes of determining the availability of a private offering exemption. 9

It is important to understand the limits of this conclusion. We recognize that securities regulation “is often a matter of the hound chasing the hare as issuers devise new ways to issue their securities and the definition of a security itself expands.” Doran v. Petroleum Management Corp., supra, 545 F.2d at 909. We insert a cautionary note because, like the Fifth Circuit in Doran, “[w]e are conscious of the difficulty in formulating black letter law in this area in light of the multiplicity of security transactions and their multifarious natures.” Id. Accordingly, we note that our holding today does not mean that anyone who has information material to an investment decision is transformed into an issuer. We hold only that when a person organizes or sponsors the organization of limited partnerships and is primarily responsible for the success or failure of the venture for which the partnership is formed, he will be considered an issuer for purposes of determining the availability of the private offering exemption. 10

a. Private Offering Exemption: § 4(2)

For nearly 30 years, the Supreme Court’s opinion in SEC v. Ralston Purina Co., supra, has provided the framework for private offering analysis. In Ralston Purina, the Court held: “[T]he applicability of [§ 4(2)] should turn on whether the particular class of persons affected needs the protection of the Act. An offering to those who are shown to be able to fend for themselves is a transaction ‘not involving any public offering.’” 346 U.S. at 125, 73 S.Ct. at 984. The Court there concluded that the company’s offering to “key employees,” who included stock clerks and bakeshop foremen, did not fall within the exemption because the employees “were not shown to have access to the kind of information which registration would disclose.” 11 Id. at 127, 73 S.Ct. at 985.

Building on these concepts, courts have developed flexible tests for the private offering exemption, focusing upon: (1) the number of offerees, Doran v. Petroleum Management Corp., supra, 545 F.2d at 900; SEC v. Continental Tobacco Co. of South Carolina, 463 F.2d 137, 158 (5th Cir. 1972); Hill York Corp. v. American International Franchises, Inc., 448 F.2d 680, 687 (5th Cir. 1971); see Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir. 1978); (2) the sophistication of the offerees, Cook v. Avien, Inc., supra, 573 F.2d at 691; Doran v. Petroleum Management Corp., supra, 545 F.2d at 902; Hill York Corp. v. American International Franchises, Inc., supra,